Monthly Archives: November 2017

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As part of a retrospective review, FINRA requested comments on FINRA Rule 5250 (the “Rule”), which generally prohibits a member firm from accepting payment from an issuer or its affiliates or promoters in exchange for making a market in the issuer’s securities. The rule prohibits a member or associated person from accepting payment or other considerations from an issuer or its affiliates and promoters, except for (i) payment for bona fide services, (ii) reimbursement of payments for SEC or state registration fees and listing fees imposed by a self-regulatory organization, and (iii) payment expressly provided for under the rules of a national securities exchange.

FINRA noted that the Rule was implemented to prevent conflicts of interest that may arise from payments for making a market in an issuer’s securities. FINRA is seeking input in several areas, including:

the effectiveness of the Rule, the impact of market changes on the need for the Rule, and alternative approaches to accomplish the goals of the Rule;

experiences with the implementation of the Rule, including ambiguities and compliance challenges;

the economic impact and unintended consequences of the Rule; and

ways to improve the Rule and related interpretations and administrative processes.

Comments must be received by January 29, 2018.

Lofchie Comment: On its face, FINRA Rule 5250 seems common-sensical. However, given the high costs of making a market in securities, and reports that there are few firms that are willing to go to the effort and expense in making markets in the securities of small issuers, it may be appropriate to allow issuers to provide a broker-dealer some reward for being willing to commit capital to make a market in the issuer’s stock, particularly if the fact of the payments and perhaps the amount and conditions were fully disclosed. Certainly it is an idea worth exploring if the regulators wish to encourage firms to provide liquidity to small issuers.

In remarks at the Federal Reserve Board of New York (“NY Fed”) Third Annual Conference on the Evolving Structure of the U.S. Treasury Market, NY Fed President and CEO William C. Dudley shared regulatory progress and identified focus areas for the U.S. Treasury Market. Mr. Dudley framed his remarks around the priorities identified in the Joint Staff Report on the extreme market volatility issued by the Treasury, the Board of Governors of the Federal Reserve System, the SEC and the CFTC on October 15, 2014.

With regard to the treasury market, Mr. Dudley expressed that improved transaction data reporting has helped to “clos[e] the data gap,” but acknowledged that there is significant work to be done to make sure that data collection is sufficient in light of expanding intermediaries and market participants. Going forward, Mr. Dudley stated, efforts will include an FRB plan to collect transaction data from depository institutions, and a focus on improving data transparency for market participants without negatively affecting market liquidity and integrity.

Mr. Dudley also identified market infrastructure as an area of focus for the Treasury market. He pointed to the clearing and settlement practices of the cash market as a particular issue that has plagued the Treasury market. Mr. Dudley said that Treasury transactions are often bilaterally cleared, which includes the involvement of several market participants and contributes to “opaque” practices. He highlighted the Treasury Markets Practice Group’s efforts in this area, suggesting that its market research can help to increase market integrity by facilitating a greater understanding of risk throughout the clearing and settlement process. Mr. Dudley further identified efforts to improve the resiliency of the repo market infrastructure, and urged a continued focus on moving towards a safer centrally cleared repo market.

Finally, Mr. Dudley reflected on the necessity of collaborative regulatory efforts to monitor the Treasury market. He asserted that the constantly evolving nature of the market demands cooperation between regulators and the public to ensure that it is appropriately and effectively regulated.

Lofchie Comment: The regulators have recently pushed the FICC to substantially increase liquidity requirements with respect to cleared swaps. This will (i) materially raise costs to firms that centrally clear swaps, and (ii) encourage firms to move back to bilateral clearing. Order Approving a Proposed Rule Change To Implement the Capped Contingency Liquidity Facility in the Government Securities Division Rulebook. In the case of the clearing of government securities, there is a flight to quality during a time of financial crisis. Consequently, there would seem to be no need for increased regulation (that is, in a crisis, liquidity will flow into governments and out of other products). So isn’t this a case where rules intended to make the markets safer by requiring firms to maintain liquidity that they won’t need, in fact, make the markets more dangerous by needlessly increasing the costs of central clearing?

Joseph M. Otting was sworn in as the 31st Comptroller of the Currency. Mr. Otting was nominated by President Donald J. Trump in June 2017, and confirmed by the U.S. Senate on November 16, 2017. He will serve a five-year term as Comptroller.

Mr. Otting succeeds Keith A. Noreika, who has served as Acting Comptroller of the Currency since Thomas J. Curry stepped down in May 2017. Before joining the OCC, Mr. Otting was a longtime banking executive, having served as President of CIT Bank, Co-President of CIT Group and Vice Chair of U.S. Bank.

In a statement, Mr. Otting said that his experiences have informed his commitment to implementing effective regulation:

“As a career banker, I know firsthand the importance of effective supervision and the value that OCC examiners and other professionals provide. I also know the challenges bankers face as they work to meet customer needs while coping with unnecessary regulatory burden that makes it more difficult and complicated than necessary. In my experience, bankers support regulation, but effective regulation evolves with the changing needs of the nation and should be reviewed and modified as those needs change.”

The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the FDIC (collectively, the “agencies”) issued a final rule extending current transitional provisions under the capital rules for certain capital deductions, risk weights and minority interest requirements. The final rule extends provisions that were set to relinquish at the end of the year. The extension is only applicable to banks that are not subject to the capital rules’ advanced approaches (institutions with total assets under $1 billion).

As previously covered, the agencies in 2013 adopted more stringent capital requirements for banking entities and organizations. These rules established certain limits on minority interests (i.e. on including assets owned by subsidiaries in regulatory capital calculations), as well as other mandates for deducting certain assets from an organization’s regulatory capital. The rules were subject to transitional provisions that allowed organizations to make appropriate preparations for the new requirements. In September 2017, the agencies proposed related capital rule simplifications that would make changes related to the treatment of certain loans, items subject to threshold deduction, and minority interest requirements. As stated in the Financial Institution Letter FIL-60-2017, the final rule extends the 2017 transition provisions for “Mortgage servicing assets; Deferred tax assets arising from differences that could not be realized through net operating loss carrybacks; Significant investments in the capital of unconsolidated financial institutions in the form of common stock; Non-significant investments in the capital of unconsolidated financial institutions; and Significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock.”

Today we release CFS monetary and financial measures for October 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.1% in October 2017 on a year-over-year basis versus 4.8% in September.

The U.S. Department of the Treasury (“Treasury”) reviewed the Financial Stability Oversight Council’s (“FSOC”) processes for non-bank financial company and financial market utility designations (“FMUs”). FSOC’s memorandum included commentary and recommendations for improvements of the process (see memorandum and fact sheet on memorandum).

Specific to the non-bank financial company determination process, Treasury recommended that FSOC prioritize an activities-based, industry-wide approach to financial stability risk management. Implementing this approach would consist of (i) identifying potential risks of activities and products, (ii) collaborating with financial regulators to address identified risks, and (iii) evaluating firms for designation in consultation with regulators. Further, Treasury recommended that FSOC take a firm’s likelihood of material stress into account and conduct a detailed cost-benefit analysis before making a designation. Treasury also suggested that FSOC improve transparency and more clearly communicate the risks that led to a designation and steps to take to appropriately “off-ramp.”

Regarding FMUs, Treasury recommended that FSOC enhance its designation process to more appropriately tailor it to individual firms. Treasury suggested that FSOC conduct further studies related to FMU operation, designation and resolution (e.g., potential access to Federal Reserve emergency facilities). Treasury also encouraged regulatory agencies to cooperate in order to develop effective strategies to enhance resilience and improve the resolution process. Further, Treasury recommended that FSOC integrate a cost-benefit analysis into the designation analysis process, enhance transparency and engagement with FMUs, and leverage expertise of primary regulators to inform regulatory and supervisory strategies.

Lofchie Comment: While improving the transparency of the FSOC process would be a significant improvement on FSOC’s operations to date, it would be better still to rethink (and to some extent junk) the discretionary designation process. The government should not have broad discretion to pick and choose on a subjective basis the firms that are to be subject to regulation. It should be easy enough to draft legislation that provided specifically for the regulation of large financial market utilities. Likewise, if Congress believes it necessary to regulate insurance companies over a certain size, then Congress should adopt legislation to that effect. Establishing and maintaining this precedent of subject determination of entities that are to be regulated is a bad idea, even if it is carried out less badly.

In a memo sent to CFPB colleagues, Mr. Cordray touted achievements during his tenure including (i) $12 billion in relief for consumers, (ii) stronger safeguards against certain mortgage practices, (iii) the processing of 1.3 million consumer complaints, and (iv) new financial education and literacy initiatives.

House Financial Services Committee Chair Jeb Hensarling (R-TX) expressed his view that Mr. Cordray’s resignation represents an opportunity to rein in the authority of the CFPB:

“We are long overdue for new leadership at the CFPB, a rogue agency that has done more to hurt consumers than help them. . . . The extreme overregulation it imposes on our economy leads to higher costs and less access to financial products and services, particularly for Americans with lower and middle incomes.”

In contrast, Committee Ranking Member Maxine Waters (D-CA) thanked Mr. Cordray for his efforts and praised the work accomplished during his tenure:

“Under his outstanding leadership, the Consumer Bureau has made the financial marketplace stronger and fairer for hardworking Americans across the country. As the first Director of the Consumer Bureau, he has overseen the implementation of much needed rules on mortgages, prepaid cards, and payday and auto title loans, clamping down on unfair practices and ensuring that consumers are not ripped off.”

Mr. Cordray was nominated to serve as the first Director of the CFPB by President Barack Obama in 2011.

Lofchie Comment: Mr. Cordray’s resignation presents an opportunity to restructure the CFPB in a manner that is consistent (i) with the bipartisan structure of other agencies, and (ii) that gives Congress and the President authority over the agency, including budgetary authority.

The existing regulatory structure now gives President Trump the ability to appoint a new head of the CFPB to serve a five year term. Without a change in structure, the new appointee will serve regardless of whether the President is re-elected or there is a new President that has different priorities. That simply makes no sense.

Likewise, the degree of authority given to the head of the CFPB is not prudent. The position is not directly accountable to the President and any appointee cannot be fired except in extraordinary circumstances. Either the head of the CFPB should be subject to dismissal by the President or the CFPB should be run by a five-person commission that would include persons who could provide some check on the director’s power.

In remarks at the Georgetown Center for Financial Markets and Policy, Commissioner Behnam expressed support for the “broad policy objectives” in Title VII of Dodd-Frank and said that the CFTC acted as a “leader” in implementing over-the-counter derivatives reforms in the wake of the 2008 financial crisis. He acknowledged that these changes have come with “costs and unintended consequences,” and expressed support for ongoing regulatory adjustments.

Commissioner Behnam identified four key reform priorities:

Mandatory clearing of swaps: Commissioner Behnam said that the clearing mandate has been largely successful, but questioned the size and interconnectedness of clearinghouses, and whether the clearing mandate and higher capital and margin requirements for uncleared swaps have “disincentivized risk management.” He said that the CFTC will evaluate the potential systemic effects of the clearing mandate, and that he will seek to bolster regulations to promote a safer clearing ecosystem.

Exchange trading of standardized swaps: Mr. Behnam noted the unintended consequences of the CFTC’s trading rules that have caused concerns as to market fragmentation and liquidity.

Swap data reporting: Mr. Behnam argued that the CFTC needs to develop requirements that establish “clear parameters” for data collection and submission, including when data must be submitted, as well as what form the data must take. He stressed the need for data set uniformity, both across the CFTC and with international regulators.

Capital and margin requirements for non-centrally cleared swaps: Noting that the CFTC has yet to adopt capital requirements for swap dealers, Mr. Behnam urged the CFTC to develop tools to monitor market resiliency, safety and liquidity in times of stress.

Mr. Behnam also highlighted three ongoing issues at the CFTC: enforcement, international cooperation and technology. In each case, he expressed general support for ongoing initiatives. As sponsor of the Market Risk Advisory Committee, Commissioner Behnam said he will engage in a “listening tour” to hear perspectives on risk management from market participants, regulators and other interested parties.

Lofchie Comment: Commissioner Behnam’s first published speech covers a lot of ground, but does not suggest that there are new initiatives that he will spearhead or that there are current initiatives that he opposes. Instead, Mr. Behnam indicates he will be in observation mode for the first part of his tenure.

In many ways, Mr. Behnam’s speech is similar to the speech given by CFTC Chair J. Christopher Giancarlo on Monday. Both Mr. Giancarlo and Mr. Behnam expressed broad support for the policy aims of Title VII of Dodd-Frank while noting a number of ways in which the current derivatives regulatory framework can be upgraded (including a handful of shared takes). One important difference may be that Chair Giancarlo believes that there were substantial problems with the CFTC’s prior rulemakings. Commissioner Benham’s remarks seem to suggest a position closer to those of former CFTC Chair Timothy Massad, who referenced the need only to “fine tune” the CFTC Title VII rules. Chair Massad never conceded the existence of material issues or attempted any significant revisions to existing rules. Given that Commissioner Benham was last in the office of Senator Stabenow (D. from Michigan), it is reasonable to expect that Chair Giancarlo intends a more ambitious clean-up of the CFTC’s rules than former Chair Massad attempted or than Commissioner Benham may be willing to support.

The U.S. Treasury Department (“Treasury”) Office of Foreign Assets Control (“OFAC”) published two Frequently Asked Questions (“FAQs”) related to economic sanctions against Venezuela.

The first FAQ (No. 547) discusses U.S. person participation in meetings concerning the restructuring of Venezuelan and Petroleos de Venezuela, S.A. (“PdVSA”) debt that existed prior to the effective date of Executive Order 13808 (“E.O. 13808”). The second FAQ (No. 548) addresses the treatment of PdVSA subsidiaries under E.O. 13808.

As previously reported, E.O. 13808 – issued on August 24, 2017 – levied restrictions to prevent U.S. persons from contributing to the Government of Venezuela’s “shortsighted financing schemes.” With certain exceptions reflected in four General Licenses issued by OFAC on the same date, E.O. 13808 generally restricted transactions with respect to the following:

new debt with a maturity of longer than 90 days of PdVSA (Venezuela’s state-owned oil and natural gas company);

new debt with a maturity of longer than 30 days, or new equity, of the Government of Venezuela;

bonds issued by the Government of Venezuela before the effective date of the Executive Order;

dividend payments or other distributions of profits to the Government of Venezuela from any entity owned or controlled, directly or indirectly, by the Government of Venezuela; and

purchasing securities, directly or indirectly, from the Government of Venezuela, other than new debt with a maturity of less than or equal to 90 days (for PdVSA) or 30 days (for other Government of Venezuela debt).

In remarks before the ISDA Regulators and Industry Forum in Singapore, Chair Giancarlo expressed support of the swap market reforms adopted by Congress in 2010, but criticized the CFTC’s prior rulemakings. He stated:

“[F]inancial regulators have a duty to apply the policy prescriptions of their legislators in ways that enhance markets and their underlying vibrancy, diversity and resiliency . . . [and t]hat duty also includes the responsibility to continuously review past policy applications to confirm they remain optimized for the purposes intended.”

Regarding rules governing the operation of SEFs, Chair Giancarlo criticized the CFTC for “attempt[ing] to re-engineer the entire market structure of swaps execution” and “dictat[ing] the business models of the SEFs themselves.” Chair Giancarlo claimed that this approach is not conducive to liquidity formation. He asserted that the regulatory framework and incongruous rules and regulations have had several “unintended” consequences, including a shift of swaps price discovery and liquidity formation from SEFs to introducing brokers. This shift, Chair Giancarlo argued, is antithetical to the intended purpose of swaps regulations and the goals of Dodd-Frank.

Chair Giancarlo criticized the CFTC’s role in not allowing SEFs to develop their own business models and in implementing “prescriptive and inflexible rules.”

Regarding swaps clearing, Chair Giancarlo explained that default risk is now managed within regulated CCPs. He emphasized the importance of the stress testing recently conducted by the CFTC in measuring the resiliency of CCPs. Recent results demonstrated the ability of three major CCPs to withstand simultaneous default of two significant clearing members, he said. Further, Chair Giancarlo promised the continued development of multi-CCP stress testing in order to create a framework that is “thorough, data driven, econometrically sound and reflective of multi-CCP operations and their role in dynamic market ecosystems.” He encouraged cooperation with the SEC and banking regulators in order to improve upon previous stress tests, and expressed confidence that collaborative efforts will continue to develop over the course of the next year. Chair Giancarlo also noted that he is open to receiving stress testing-related input from European regulators, but reiterated his opposition to certain European Union proposals that would subject certain U.S. CCPs to European oversight.

Lofchie Comment: Chair Giancarlo’s remarks are a blunt criticism of prior rulemakings. Mr. Giancarlo has been consistent in arguing that while the government should regulate markets, it should not dictate or re-invent market structures (and, if it is so ambitious as to do so, it should at least check whether its dictates are having the intended effect). Notwithstanding this criticism of prior rulemakings, the Chair has nothing but good things to say about Dodd-Frank. Even those who do not share this optimism are hoping that he is able to make a silk purse from a sow’s ear.

Those who have a view as to how the swaps markets should function should be seeking this opportunity to get their views in front of the CFTC. While some of the major market participants have already expressed their thoughts through the CFTC’s “KISS” project, the fix of the CFTC’s existing rules will take a good bit of time, and there is thus still opportunity for diverse views to be heard. Further, given that the existing CFTC rules did not draw support from either the buy-side or the sell-side, it is hard to imagine that there is much support for the status quo.